Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes ý☒  No o☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes ý☒        No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

As of August 4, 2015,July 29, 2016, there were 21,111,58521,479,885 shares of the registrant’s common stock, no par value per share, outstanding.

 

See Notes to Condensed Consolidated Financial Statements.

See Notes to Condensed Consolidated Financial Statements.

See Notes to Condensed Consolidated Financial Statements.

Charles & Colvard, Ltd. (the “Company”), a North Carolina corporation founded in 1995, manufactures, markets, and distributes Charles & Colvard Created Moissanite^® jewels (hereinafter referred to as moissanite or moissanite jewels), and finished jewelry featuring moissanite and fashion finished jewelry for sale in the worldwide jewelry market.  Moissanite, also known by its chemical name of silicon carbide (“SiC”)(SiC), is a rare mineral first discovered in a meteor crater.  Because naturally occurring SiC crystals are too small for commercial use, larger crystals must be grown in a laboratory.  Leveraging its advantage of being the original and leading worldwide source of created moissanite jewels, the Company’s strategy is to establish itself with reputable, high-quality, and sophisticated brands and to position moissanite as an ethically-sourced, affordable, and luxurious alternative to other gemstones such as diamond. The Company believes this is possible due to moissanite’s exceptional brilliance, fire, durability, and rarity like no other jewel available on the market. The Company sells loose moissanite jewels and finished jewelry at wholesale to distributors, manufacturers, and retailers and at retail to end consumers through its wholly owned operating subsidiaries, Moissanite.com, LLC and Charles & Colvard Direct, LLC.LLC (until March 2016), and through third-party marketplaces.

Basis of Presentation and Principles of Consolidation - The accompanying unaudited condensed consolidated financial statements included in this Quarterly Report on Form 10-Q have been prepared in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information. However, certain information or footnote disclosures normally included in complete financial statements prepared in accordance with U.S. GAAP have been condensed, or omitted, pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). In the opinion of the Company’s management, the unaudited statements in this Quarterly Report on Form 10-Q include all normal and recurring adjustments necessary for the fair statement of the results for the interim periods presented. The results for the three and six months ended June 30, 20152016 are not necessarily indicative of the results to be expected for the fiscal year ending December 31, 2015.2016.

The condensed consolidated financial statements as of and for the three and six months ended June 30, 20152016 and 20142015 included in this Quarterly Report on Form 10-Q are unaudited. The balance sheet as of December 31, 20142015 is derived from the audited financial statements as of that date. The accompanying statements should be read in conjunction with the audited financial statements and related notes, together with Management’s Discussion and Analysis of Financial Condition and Results of Operations, contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 20142015 filed with the SEC on March 13, 20158, 2016 (the “2014“2015 Annual Report”).

The accompanying condensed consolidated financial statements as of and for the three and six months ended June 30, 20152016 and 20142015 include the accounts of the Company and its wholly owned subsidiaries Moissanite.com, LLC, formed in 2011; Charles & Colvard Direct, LLC, formed in 2011; and Charles & Colvard (HK) Ltd., the Company’s Hong Kong subsidiary that became a dormant entity in the second quarter of 2009 and the operations of which ceased in 2008. All intercompany accounts have been eliminated.

Significant Accounting Policies - In the opinion of the Company’s management, the significant accounting policies used for the three and six months ended June 30, 20152016 are consistent with those used for the year ended December 31, 2014.2015. Accordingly, please refer to the 20142015 Annual Report for the Company’s significant accounting policies.

Use of Estimates - The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. The most significant estimates impacting the Company’s condensed consolidated financial statements relate to valuation and classification of inventories, accounts receivable reserves, depreciable lives of property and equipment, deferred tax assets, uncertain tax positions, stock compensation expense, and cooperative advertising. Actual results could differ materially from those estimates.

Reclassifications - Certain amounts in the prior year’s condensed consolidated financial statements have been reclassified to conform to the current year presentation, primarily amounts described in Note 3, “Segment Information and Geographic Data” and Note 12, “Discontinued Operations” related to changes in the Company’s reportable segments.

In August 2014,July 2015, the FASB issued new accounting guidance intendedthat will require an entity to define management’s responsibility to evaluate whether there is substantial doubt about an organization’s ability to continue as a going concern and to provide related footnote disclosures. Under U.S. GAAP, financial statements are preparedmeasure inventory valued under the presumption thataverage cost method from the reporting organization will continuelower of cost or market to operatethe lower of cost or net realizable value, with net realizable value defined as the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. No other changes were made to the current guidance on inventory measurement. This guidance is effective on a going concern, except in limited circumstances. The going concern basis of accounting is critical to financial reporting because it establishes the fundamentalprospective basis for measuringpublic entities for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. Early application is permitted as of the beginning of an interim or annual reporting period.  The Company does not anticipate early adoption at this time and classifying assets and liabilities. Currently, U.S. GAAP lacksis currently evaluating the impact of this guidance about management’s responsibility to evaluate whether there is substantial doubt abouton its consolidated financial statements.

In November 2015, the organization’s ability to continue as a going concern or to provide related footnote disclosures. ThisFASB issued new accounting guidance provides guidance to an organization’s management, with principlesthat requires that deferred tax assets and definitions that are intended to reduce diversityliabilities be classified as noncurrent in the timing and contenta classified statement of disclosures that are commonly provided by organizations today in the financial statement footnotes. This new accountingposition. The guidance is effective for financial statements issued for annual periods endingbeginning after December 15, 2016, and interim periods within those annual periods. Earlier application is permitted for all entities as of the beginning of an interim or annual report period. The amendments in this guidance may be applied either prospectively to all deferred tax assets and liabilities or retrospectively to all periods presented. The Company adopted this standard as of December 31, 2015 with prospective application. As a result, the Company reclassified its deferred tax assets classified as current to noncurrent and its deferred tax liabilities classified as current to noncurrent in its December 31, 2015 consolidated balance sheet.

In February 2016, the FASB issued new guidance that establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either financing or operating, with classification affecting the pattern of expense recognition in the income statement.  The new standard is effective for fiscal years beginning after December 15, 2016. Early application2018, including interim periods within those fiscal years. A modified retrospective transition approach is permittedrequired for annuallessees for capital and operating leases existing at, or interim reporting periods for whichentered into after, the beginning of the earliest comparative period presented in the financial statements, have not previously been issued.with certain practical expedients available.  The Company does not expectis currently evaluating the impact of its pending adoption of the new standard on its consolidated financial statements.

In March 2016, the FASB issued updated guidance that changes how companies account for certain aspects of share-based payment awards to employees, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as the classification of related matters in the statement of cash flows. The update is effective for the Company in the first quarter of 2017. The Company is currently evaluating this new accounting guidance and the impact it will have a material impact on its consolidated financial statements.

All other new and recently issued, but not yet effective, accounting pronouncements have been deemed to be not relevant to the Company and therefore are not expected to have any impact once adopted.

The Company reports segment information based on the “management” approach. The management approach designates the internal reporting used by management for making operating decisions and assessing performance as the source of the Company’s operating and reportable segments.

During 2014,Previously, the Company began managingmanaged its business primarily through the three distribution channels that it usesused to sell its product lines, loose jewels and finished jewelry.jewelry, which included Charles and Colvard Direct, LLC. Accordingly, the Company determined its three operating and reportable segments to be wholesale distribution transacted through the parent entity, and the two direct-to-consumer distribution channels transacted through the Company’s wholly owned operating subsidiaries, Moissanite.com, LLC and Charles & Colvard Direct, LLC.  On March 4, 2016, the Company divested its direct-to-consumer home party business previously operated through its Charles & Colvard Direct, LLC (dba Lulu Avenue^®) subsidiary.  As a result, during the three months ended March 31, 2016, the Company began managing its business primarily through its two continuing distribution channels. Accordingly, the Company is presenting segment results for the two continuing operating and reportable segments within this footnote and the segment results for Charles & Colvard Direct, LLC within Note 12, “Discontinued Operations” of this Quarterly Report on Form 10-Q. The accounting policies of these three segments are the same as those described in Note 2, “Basis of Presentation and Significant Accounting Policies” of this Quarterly Report on Form 10-Q and in the Notes to the Consolidated Financial Statements in the 20142015 Annual Report.

The Company evaluates the financial performance of its segments based on net sales; product line gross profit, or the excess of product line sales over product line cost of goods sold; and operating income (loss). Product line cost of goods sold is defined as product cost of goods sold in each of the Company’s wholesale distribution and two direct-to-consumer distribution operating segmentssegment excluding non-capitalized expenses from the Company’s manufacturing and production control departments, comprising personnel costs, depreciation, rent, utilities, and corporate overhead allocations; freight out; inventory valuation allowance adjustments; and other inventory adjustments, comprising costs of quality issues, damaged goods, and inventory write-offs.

The Company allocates certain general and administrative expenses from its parent entity to its two direct-to-consumer distribution segmentssegment primarily based on net sales and number of employees.employees to arrive at segment operating loss. Unallocated expenses, which also include interest and taxes, remain in the parent entity’s wholesale distribution segment.

Summary financial information by reportable segment is as follows:

A reconciliation of the Company’s product line cost of goods sold to cost of goods sold as reported in the condensed consolidated financial statements is as follows:

Supplies inventories of approximately $40,000 and $51,000$38,000 at June 30, 20152016 and December 31, 2014,2015, respectively, included in finished goods inventories in the condensed consolidated financial statements are omitted from inventories by product line because they are used in both product lines and are not maintained separately.  The Company’s twocontinuing operating subsidiaries comprising the two direct-to-consumer distribution segments carrysubsidiary carries no net inventories, and inventory is transferred without intercompany markup from the parent entity’s wholesale distribution segment as product line cost of goods sold when sold to the end consumer.

Inventories are stated at the lower of cost or market on an average cost basis. Inventory costs include direct material and labor, inbound freight, purchasing and receiving costs, inspection costs, and warehousing costs. Any inventory on hand at the measurement date in excess of the Company’s current requirements based on historical and anticipated levels of sales is classified as long-term on the Company’s consolidated balance sheets. The Company’s classification of its inventory as either short- or long-term inventory requires it to estimate the portion of on-hand inventory that can be realized over the next 12 months and does not include precious metal, labor, and other inventory purchases expected to be both purchased and realized in cost of goods sold over the next 12 months.

The Company’s work-in-process inventories include raw SiC crystals on which processing costs, such as labor and sawing, have been incurred; and components, such as metal castings and finished good moissanite jewels, that have been issued to jobs in the manufacture of finished jewelry. The Company’s moissanite jewel manufacturing process involves the production of intermediary shapes, called “preforms,” that vary depending upon the size and shape of the finished jewel. To maximize manufacturing efficiencies, preforms may be made in advance of current finished inventory needs but remain in work-in-process inventories. As of June 30, 20152016 and December 31, 2014,2015, work-in-process inventories issued to active production jobs approximated $1.40$6.01 million and $2.05$3.02 million, respectively.

The Company’s jewels do not degrade in quality over time and inventory generally consists of the shapes and sizes most commonly used in the jewelry industry. In addition, the majority of jewel inventory is not mounted in finished jewelry settings and is therefore not subject to fashion trends nor is obsolescence a significant factor. The Company has very small market penetration in the worldwide jewelry market, and the Company hashad the exclusive right in the U.S. through mid-2015August 2015 and has the exclusive right in many other countries through mid-2016into the third quarter of 2016 to produce and sell created SiC for use in jewelry applications. During the three monthsyear ended June 30,December 31, 2015, management identified an opportunity to sell approximately $2.28 million of slow movingslow-moving loose jewel inventory of less desirable quality.  As a result of this sale and feedback from customers on the value of some of these goods, the Company determined a lower of cost or market reserve of $103,000$528,000 and $352,000 as of June 30, 2016 and December 31, 2015, respectively, was required on some of the remaining inventory of these lower quality goods.  In view of the foregoing factors, management has concluded that no excess or obsolete loose jewel inventory reserve requirements existed as of June 30, 2015 on goods other than the lower quality goods noted previously.

The Company manufactures finished jewelry featuring moissanite. Relative to loose moissanite jewels, finished jewelry is more fashion oriented and subject to styling trends that could render certain designs obsolete. The majority of the Company’s finished jewelry featuring moissanite is held in inventory for resale and consists of such basic designs as stud earrings, solitaire and three-stone rings, pendants, and bracelets that tend not to be subject to significant obsolescence risk due to their classic styling. In addition, the Company manufactures small individual quantities of designer-inspired moissanite fashion jewelry as part of its sample line that are used in the selling process to its wholesale customers.

In 2011,Prior to March 2016, the Company began purchasingpurchased fashion finished jewelry comprised ofcomprising base metals and non-precious gemstones for sale through Lulu Avenue^®, the Company’s former direct-to-consumer home party division of itsthe Company’s wholly owned operating subsidiary, Charles & Colvard Direct, LLC. This finished jewelry iswas fashion oriented and subject to styling trends that maycould change with each catalog season, of which there are severalgenerally two each year. Typically in the jewelry industry, slow-moving or discontinued lines are sold as closeouts or liquidated in alternative sales channels.  The CompanyManagement reviews the finished jewelry inventory on an ongoing basis for any lower of cost or market and obsolescence issues.  The CompanyManagement identified certain fashion finished jewelry inventory that could not be sold due to damage or branding issues and established an obsolescence reserve of $536,000$155,000 as of June 30, 20152016 and $250,000$164,000 as of December 31, 2014,2015, for the carrying costs in excess of any estimated scrap values.  As of June 30, 20152016 and December 31, 2014, the Company2015, management identified $86,000 and $31,000, respectively ofcertain finished jewelry featuring moissanite that requiredwas obsolete due to damage and other factors that indicate the finished jewelry is unsaleable, and established an obsolescence reserve.reserve of $185,000 and $225,000, respectively, for the carrying costs in excess of any estimated scrap values.

Periodically, the Company ships finished goods inventory to wholesale customers on consignment terms. Under these terms, the customer assumes the risk of loss and has an absolute right of return for a specified period. Finished goods on consignment at June 30, 20152016 and December 31, 20142015 are net of shrinkage reserves of $25,000$39,000 and $53,000,$37,000, respectively, to allow for certain loose jewels and finished jewelry on consignment with wholesale customers that may not be returned or may be returned in a condition that does not meet the Company’s current grading or quality standards.

Total net loose jewel inventories at June 30, 20152016 and December 31, 2014,2015, including inventory on consignment net of reserves, were $29.23$22.05 million and $31.95$28.19 million, respectively. The loose jewel inventories at June 30, 20152016 and December 31, 20142015 include shrinkage reserves of $142,000$47,000 and $17,000,$50,000, respectively, with $8,000which includes $6,000 and $17,000$10,000 of shrinkage reserves on inventory on consignment at June 30, 20152016 and December 31, 2014,2015, respectively. Loose jewel inventories at June 30, 20152016 and December 31, 20142015 also include recutsrecut reserves of $366,000$400,000 and $216,000,$449,000, respectively.

Total net jewelry inventories at June 30, 20152016 and December 31, 2014,2015, including inventory on consignment net of reserves, finished jewelry featuring moissanite manufactured by the Company, since entering the finished jewelry business in 2010, and fashion finished jewelry purchased and owned by the Company which was made for sale through Lulu Avenue^®, were $5.26$4.00 million and $6.93$4.10 million, respectively. Jewelry inventories consist primarily of finished goods, a portion of which the Company acquired as part of a January 2009 settlement agreement with a former manufacturer customer to reduce the outstanding receivable to the Company. Due to the lack of a plan to market this inventory at that time, a jewelry inventory reserve was established to reduce the majority of the acquired jewelry inventory value to scrap value, or the amount the Company would expect to obtain by melting the gold in the jewelry and returning to loose-jewel finished goods inventory those jewels that meet grading standards. The scrap reserve established for this acquired inventory at the time of the agreement is adjusted at each reporting period for the market price of gold and has generally declined as the associated jewelry is sold down. At June 30, 2015, the balance decreased to $66,000 from $101,000 at December 31, 2014 as a result of melting a majority of the jewelry, some sell down of the inventory during the quarter, and change in gold prices. Because the finished jewelry the Company began manufacturing in 2010 after it entered that business was made pursuant to an operational plan to market and sell the inventory, it is not subject to this reserve.  The finished jewelry inventories at June 30, 20152016 and December 31, 20142015 also include shrinkage reserves of $167,000$93,000 and $192,000,$95,000, respectively, including shrinkage reserves of $17,000$33,000 and $36,000$27,000 on inventory on consignment, respectively; and a repairs reserve of $63,000$14,000 and $127,000,$31,000, respectively.

The need for adjustments to inventory reserves is evaluated on a period-by-period basis.

The Company recognized an income tax net expense of approximately $4,000 and $3,000, respectively, for the three months ended June 30, 2016 and 2015, compared to an income tax net expense of approximately $4.15 million for the three months ended June 30, 2014.  The Company recognized an income tax net expense of approximatelyand $7,000 and $6,000, respectively, for the six months ended June 30, 2016 and 2015, compared to an incomefor estimated tax, net expense of $4.05 million for the six months ended June 30, 2014.penalties, and interest associated with uncertain tax positions.

As of each reporting date, the Company’s management considers new evidence, both positive and negative, that could impact its view with regard to future realization of deferred tax assets. The Company had previously considered various strategic alternatives that would reduce its pre-tax operating losses, resulting in management determining that a valuation allowance was not necessary at March 31, 2014.  During the three months endedAs of June 30, 2014,2016 and December 31, 2015, the Company’s management determined that such strategic alternatives were no longer in the best interest of the Company.  Accordingly, the Company’s management concluded that the positive evidence was no longer sufficient to offset available negative evidence primarily as a result of the pre-tax operating losses incurred during the six months ended June 30, 2014, and forecastedcontinued to continue through the remainder of 2014.  As a result, the Company’s management concluded thatexist to conclude it was uncertain that the Company would have sufficient future taxable income to utilize its deferred tax assets, and therefore, the Company establishedmaintained a valuation allowance against its deferred tax assets resulting in a tax expenseassets.